On November 12th, President Lee Myung Bakdeclared in a cabinet meeting “It is up to us the developed nations to reducehazardous gas emissions.” The President continued that Korea will reduce itsGreenhouse Gas emissions by 4% until 2020 in contrast to the 2005 level.

The environment has grown into a centralissue in the global sphere. Efforts to ‘cap’ emissions have been implemented astaxes and fines in many developed nations around the world. However, the ‘cap’itself has not been efficient until a second element was introduced into thepollution problem. Since the late 1960’s awareness about grave environmentalpollution by human industrial activity has concerned economists in earnest. Amarket solution was proposed, and the second element of ‘trade’ was put underconsideration. In this presentation, we will explore the history, the conceptand the economic effects of emissions trading, or more simply put, ‘cap andtrade.’

The cap and trade solution to air pollutionabatement was first simulated between 1967 and 1970 by Ellison Burton andWilliam Sanjour under the US National Air Pollution Control Administration.They used mathematical models of several cities and their emission sources inorder to compare the cost and effectiveness of various control strategies. Thestudy proved that there are simply more effective ways to reduce pollution andthey were far superior to others.

This led to the concept of "cap andtrade" as a means of achieving the "least cost solution" for agiven level of abatement.

This is a brief history of the cap andtrade policy under four distinct stages.

1.         Gestation:Theoretical articulation of the instrument (by Coase,[14] Crocker,[15]Dales,[16] Montgomery etc.) and, independent of the former, tinkering with"flexible regulation" at the US Environmental Protection Agency.

2.         Proofof Principle: First developments towards trading of emission certificates basedon the "offset-mechanism" taken up in Clean Air Act in 1977.

3.         Prototype:Launching of a first "cap-and-trade" system as part of the US AcidRain Program, officially announced as a paradigm shift in environmental policy,as prepared by "Project 88", a network-building effort to bringtogether environmental and industrial interests in the US.

4.         Regimeformation: branching out from the US clean air policy to global climate policy,and from there to the European Union, along with the expectation of an emergingglobal carbon market and the formation of the "carbon industry".

This is a coal power plant in Germany. Dueto emissions trading, coal may become less competitive as a fuel.

We can find examples of emissions traderegimes in a series of legislations and international agreements. In reality,there are a number of different trading programs according to types of airpollutants. The European Union Emission Trading Scheme is the largest greenhousegas allowance market in effect. In the United States there is a domestic marketto reduce acid rain and several regional markets for nitrogen oxides. There aresmaller and more localized markets for other various pollutants.

Emissions trading aims to control pollutionby providing economic incentives for reducing the emissions of pollutants. Itis in essence an administrative measure, which requires a central governingbody to set up criteria and enforce penalties. The two necessary criteria are naturallythe limit or cap of the amount of specific pollutant that may be emitted, andthe unit rate at which trade may be established. This unit in sum willconstitute a definite amount of “allowances.” This “allowance” functions as acurrency in the market. Companies and groups are initially allotted specificshares of “allowances” by an authority or regime. From here, companies withemissions that exceed their initial allowances must purchase shares from othercompanies that can manage their emissions below their assigned level. Aggregatetransfers of allowances will result in rewarding those who reduce theirpollutant emissions and fine those who must buy extra allowances. Consequently,those who can reduce emissions most cheaply will do so, achieving the pollutionreduction at the lowest cost to society as a whole.

In sum, the goal of an emissions tradingplan is to minimize the cost of reducing pollution. Although there are distinctelements of free market in the emissions trading theory, emissions tradingrequires a cap to effectively reduce emissions, and the cap is a government regulatorymechanism. Therefore cap and trade is not entirely "free market"environmentalism. The entire procedure is premised on government interventionin the form of a cap. Only after a cap has been set by a political process,individual companies are free to choose how or if they will reduce theiremissions. Failure to reduce emissions is often punishable by a furthergovernment regulatory mechanism. Thus, on a national level, individualcompanies will face increasing factors of production, now that they must payfor the pollutants they emit during production.

On a global level, there are growingconcerns that cap and trade system may function as a new trade barrier.

CONCLUSION:

For newly developed industries anddeveloping countries, cap and trade is an entry barrier. Developed nations wishto impose economic sanctions to pressure all countries to join their protocol. Thenew cost incurred by CO2 permits is expected to account for roughly 20% of thetotal production cost.

Since cap and trade system is governed by principlesof supply and demand, it is vulnerable to weaknesses of the market systemitself. The significant price discrepancies across different market scenarios openup unfair opportunities. In fact, there are a limited number of players withaccess to multiple market schemes, who can realize their speculativeintentions. For instance, a number of MNC’s exploit price difference between EUemission permits and UN credits, where arbitrage allows for as much as $1billion a year in profit. Moral hazard is indeed a serious threat to therealization of the essential objective of cap and trade—reduction of overallpollution level. Some speculators go as far as to purchase permits at lowerprices during economic recession, only to resell them for profit when theeconomy recovers.[1]

On a larger scale, cap and trade systemburdens poor countries to keep them from advancing their economy. CO2 becomes anew cost factor as permits become a new commodity. While developing nationsrequire additional CO2 permits, lack of funds to buy surplus to use for theirown industry is sold to richer countries. This results in a malicious cycle ofsequential poverty. Consequently, increasing production cost causes prices torise, compromising production competency for developing and newly developedcountries.

In sum, whether the overall benefits of capand trade outweighs the negative outcomes such as its rising role as a new formof protectionism is a controversial issue.